Two Words

This note was originally published
at 8am on December 17, 2014 for Hedgeye subscribers.

“Narrative is linear, but Action... having breadth and depth, as well as length - is solid.”

-Thomas Carlyle

This morning, the investing world is waiting on a critical two-word pronouncement from the Fed. Sitting in my hotel room here in London, drinking a Red Bull (it’s 4:30am and the British don’t have any coffee ready!), it's difficult not to find the idea of many of us sitting and waiting on the edge of our seats for a small word change just a bit laughable.

According to Bloomberg:

“Sixty-eight percent of 56 economists surveyed by Bloomberg late last week said the Federal Open Market Committee will drop its pledge to keep interest rates near zero for a “considerable time” and instead adopt a word such as “patient” to describe its approach to policy. Only 23 percent said the committee will keep “considerable time.”

On on hand, given how bad most economists are at predicting actual economic figures, opining on language in central bank statements might actually be a better use of their time. But regardless there you go, if the Fed keeps “considerable time” in its policy statement, this will be perceived as dovish, and if it changes its language to “patient” this will be perceived as hawkish.

There is also a tail scenario where the Fed does something completely different, but far be it for any traditional economists to opine on something that doesn’t fit a linear narrative. Currently, the most popular narrative out there is that the U.S. is decoupling from the global economy. While that may be true now, and to a point, it has also become fairly consensus.

Back to the Global Macro Grind...

On the topic of the U.S. economy, it has been out-performing many major economies this year and at up +6.7% for the year-to-date the SP500 is in part reflecting this. In addition, if it weren’t for energy (the XLE is down over -16%) the SP500’s performance would be much stronger. That said, it is likely a narrative fallacy to believe that if the world catches an economic cold, the U.S. won’t at a minimum sneeze.

My colleague Darius Dale did a comprehensive presentation yesterday on emerging markets and his conclusion was somewhat dire. While he acknowledges that many emerging markets have underperformed year-to-date, he also uses history as a guide which suggests a scenario of increasing emerging market calamity due to strong U.S. dollar in combination with emerging market illiquidity (among other things).

Certainly, the case can be made, as we have, that a strong U.S. dollar is good for the U.S. economy, but the greater global risk is that it moves too far and too quickly, which puts the squeeze on emerging economies that issue debt in U.S. dollars and pay it off in local currency.

In fact, according to some estimates “international banks had loaned $3.1 trillion to emerging markets by the middle of this year, mainly in dollars. Such nations had also issued international debt securities totaling $2.6 trillion, of which three-quarters was in dollars.” That, my friends, is a lot of U.S. dollar denominated debt in the hands of some potentially very weak economic hands.

So, to the extent that emerging economies have less access to capital because of a strong dollar (the data is already showing they do) or in a more extreme scenario, have challenges paying back U.S. dollar debt, there will be increasing economic headwinds globally and we’d be naïve to think that won’t impact U.S. growth.

In fact, as we show in the Chart of the Day below, this idea of emerging economies is a bit of a misnomer. According to our analysis, on a purchasing parity basis the so called “emerging economies” comprised 56% of global GDP share in 2013. Moreover, in the same year emerging economies comprised 73% of global growth. So as emerging markets go, so to goes global economic growth.

Now to be fair to the bullish narrative on the U.S., in the last full year of 2013, only about 9.4% of U.S. GDP was from exports, so relative to many economies, the U.S. is much more self-sufficient. The obvious caveat is that from 2009 to 2013, exports also grew by about 49%, so the increase in exports has been a notable tailwind to U.S. GDP.

More critically, for those of us who are stock market operators at least, is the fact that almost a full 1/3 of SP500 corporate revenue comes from international sources. So even if the U.S. continues to hum along alone, if the global economy does decelerate, so too will U.S. corporate profits. And while the U.S. stock market could continue to move higher in that scenario, we’d probably be hedged.

Inasmuch as we are disbelievers in a complete decoupling scenario, there are certainly positives in the U.S.: a “tightish” labor market, meaningfully lower energy costs and a new one for our ledger... an improving housing market. Incidentally, we will be outlining our housing narrative (albeit a narrative with facts and analysis) at 1pm eastern today.

The key components of this new thesis are as follows:

Progress: The same model that underpinned our long thesis in housing in 2012/13 and short position in 2014 is signaling another inflection as we head into 2015;

Fledgling Inflection: 2nd derivative trends matter in housing and, from a rate of change perspective, most of the data is beginning to inflect positively; and

Opening the Credit Box: After a discrete tightening in 2014, credit constraints should show marginal easing in 2015.

Excerpt: Detecting Deception

Earlier this month our Restaurants Team held a conference call for institutional investors Statement Analysis - Putting Companies Through a Linguistic Polygraph Test with former U.S. Deputy Marshall Mark McClish.

Mark McClish is the author of I Know You Are Lying and the creator of the Statement Analysis method. In this brief excerpt Mark explains how to identify signs of deception and dissects an excerpt from HAIN’s Q1 earnings call as an example.

Reading conference call and analyst meeting transcripts is a key part of the analyst’s job. We all use words to define our reality, and our choice of words can be revealing. The premise of Statement Analysis is that a person’s choice of specific words can reveal when there might be an attempt at deception. This Statement Analysis exercise looks exclusively at a company’s written and verbal statements. Using these hidden clues, we can dig deeper into a company’s public pronouncements for signals of potential concerns in a company’s reporting.

Cartoon of the Day: Oil Plunge!

Oil prices have slumped almost 50% this year, set for the biggest annual decline since 2008. "It's flat out ugly for whoever is long inflation expectations in Energy terms," says Hedgeye CEO Keith McCullough.

Takeaway: The ICSC numbers end the year on a low note decelerating on a 1,2, and 3 yr basis after the pre-Christmas rebound which we suspect was helped by retailers need to clean up inventory positions headed into January. Since the week 36 peak, the trend has been overwhelmingly negative. That being said, comps in the first calendar quarter of 2015 get very easy with an average comp of 1.6% compared to the rest of the year at 3.1%.

COMPANY HIGHLIGHTS

UA - Under Armour Signs Andy Murray

Takeaway:At 27 Murray isn't quite a tennis dinosaur but he's getting close. Still this is a coup for UA which was able to steal him away from Adi. The 4 year deal is just north of $5mm per year or about 2% of the company's 2014 projected marketing spend and less than a half of a percent of total revenue. That's a drop in the bucket for UA. And it gives them a bonafide presence on the court. The company's current lineup of athletes (Sloane Stephens and Robert Ginepri) don't spend a lot of time playing in front of a national TV crew. UA has been unafraid to diversify, trying its hand at everything from speed skating to supermodels, so tennis is a logical extension for the brand. At the price that they are paying…this is a win for UA.

Takeaway: If we assume that each order on average cost the consumer $5 to ship, we get to a total of 400 million packages shipped for free this holiday season, up 100mm units or 33% from last year. That's pretty damaging for the rest of retail. Especially when you consider the drag it has on profitability. AMZN pays close to 10% of it's revenue to cover its shipping expense every year and its e-comm operation is 6x bigger than WMT and 16X bigger than M. If it's an issue for AMZN you can bet it's a bigger issue at just about every other retailer on the planet. We've seen that from KSS where the online EBIT margin is 4% margin compared to Brick and Mortar closer to 10%. Historically, retailers have been lemmings when it comes to shipping charges and we think the trend towards free continues.

Case/Shiller | HPI Stabilization Confirmation Redux

Takeaway:Case/Shiller is now showing similar trends in HPI stabilizing on a second derivative basis as Corelogic & FHFA.

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.

Today's Focus: October S&P/Case-Shiller Home Price Report

THE DATA: The Case-Shiller HPI data for October showed home prices growing +4.5% YoY, decelerating -30bps from +4.8% in September. Recall that the Case-Shiller HPI series is constructed as a 3-month moving average so the October release reflects HPI changes over the Aug-to-Oct period, effectively amounting to September data. The Case-Shiller series tracks the Corelogic data closely, but on a lag, and with the Corelogic figures released almost a full month before Case-Shiller, the slope and likely magnitude of the C-S HPI is pretty well advertised.

BOTTOM-LINE:Home-Price growth continued to decelerate but, from a modeling perspective, we're primarily concerned with the rate of deceleration and, on that score, the trend remains one of improvement. The sequential change in the YoY Rate of Change improved to -0.3% in October from -0.8% the month prior. As we’ve highlighted alongside the other HPI releases, all three primary price series are now confirming the same (2nd derivative) stabilization story. The 1st chart below illustrates that trend. Given the correlation between 2nd derivative HPI trends and housing related equities, a stabilization/re-acceleration in home price growth augurs positively for the group.

About Case Shiller:

The S&P/Case-Shiller Home Price Index measures the changes in value of residential real estate by tracking single-family home re-sales in 20 metropolitan areas across the US. The index uses purchase price information obtained from county assessor and recorder offices. The Case-Shiller indexes are value-weighted, meaning price trends for more expensive homes have greater influence on estimated price changes than other homes. It is vital to note that the index’s printed number is a 3-month rolling average released on a two month delay.

Frequency and Release Date:

The S&P/Case-Shiller HPI is released on the last Tuesday of every month. The index is on a two month lag and therefore does not reflect the most recent month’s home prices.

Joshua Steiner, CFA

Christian B. Drake

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